Interest rates are likely to rise further in the coming months, as Jerome Powell and the rest of the Fed are unable to declare victory against high inflation soon, especially as consumer prices rose 8.6% year on year in May.
In fact, the chances of rising by three quarters of a percentage point on Wednesday, although still a little distant, increased after the May CPI report.
“The Fed needs to show determination. It can’t afford to seem unconvinced about this stubborn and persistent inflation. The next two meetings need to be raised by half a point,” said Todd Lowenstein, chief equity strategist. The Private Bank in Union Bank.
But Lowenstein acknowledged that there is a growing debate over whether the Fed should slow the pace of interest rates or even pause for a meeting later this year to assess the impact of higher interest rates on the economy more broadly. There is a delay between announcing higher rates and actually slowing down consumer spending.
Of course, a pause seems less likely after the hot inflation report for May. In fact, traders are now pricing with more than a 40% chance of a three-quarter increase in the Fed’s July meeting. Economists at Barclays wrote on Friday that it was “close” whether the Fed would raise interest rates as much in June or July.
However, not everyone thinks the Fed should be so aggressive. The Fed has launched a process called quantitative tightening, which could slow consumer demand by raising long-term interest rates.
Here’s how it works: As part of the Fed’s efforts to stimulate Covid by 2020, the central bank bought huge amounts of bonds and mortgaged securities. This so-called quantitative easing has pushed the Fed’s balance sheet to a hefty $ 9 trillion.
The Fed is now disbanding some of these assets, leaving bonds on its balance sheet to fall and not reinvesting principal payments back into those bonds. In theory, this should increase long-term profitability. This may be another reason for fears of numerous large increases in Fed interest rates to be exaggerated.
“Quantitative tightening will definitely lead to higher long-term interest rates, and I don’t think the market is taking that into account. Investors are probably expecting an overbearing Fed, “said Sandy Wheeler III, portfolio manager at St. Louis. Denis J. Villere & Co. “The market reacts too much and that gives us opportunities to buy some things.”
Wheeler said bonds and some small-cap US companies look attractive. But he acknowledged that investors should be cautious. There is no guarantee that the Fed can slow the economy without causing a recession.
“We will see if the Fed can perform this magic trick and have a soft landing instead of an emergency landing. There is no doubt that the Fed is waiting too long to react to inflation,” Wheeler said.
Others worry that large increases in Fed interest rates will not help reduce inflation, especially since much of the higher prices are due to rising energy costs. And unless the Fed somehow manages to mediate a peace agreement between Russia and Ukraine, we will soon see some relief from the pump.
“We were hoping to reach peak inflation,” said Jay Woods, chief market strategist at DriveWealth. “But the Fed doesn’t control the price of oil and gas. Consumer spending habits will change dramatically.”
Technical canaries in the coal mine?
Technology stocks have a brutal year. Nasdaq is in a bear market as investors worry about the impact of higher interest rates on Silicon Valley profits. Are the fears justified? Investors will get a better feel after two giant software companies – Oracle (ORCL) and Adobe (ADBE) – report their profits this week.
Both companies have a large exposure to Corporate America. Oracle is a leader in database and customer relationship management software, while Adobe’s creative tools (PhotoShop, Acrobat, and InDesign, to name a few) are used by armies of business graphics designers.
Shares of Oracle and Adobe, as well as other technologies, fell this year. Shares of Oracle fell nearly 25 percent, while Adobe fell more than 30 percent.
Investors will pay close attention to see what each company has to say about the prospects for corporate technology spending over the next few months and beyond. They could give Wall Street more clues about how other cloud software giants, such as Microsoft (MSFT), Google (GOOGL), SAP (SAP) and Amazon (AMZN), are doing. Another cloud leader, Dow Salesforce (CRM), recently reported strong gains. But the company has slashed its prospects and also said it plans to be more “measured” about hiring in the future.
Next
Monday: Profits from Oracle
Tuesday: US producer prices
Wednesday: US retail; Federal Reserve Policy Communication
Thursday: start of US housing construction and building permits; weekly U.S. unemployment applications; profits from Kroger (KR), Jabil (JBL) and Adobe
Friday: Industrial production in the United States
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